On April 14 we posted a discussion entitled “How Deficits Are Financed Does Matter”
(see link below). We pointed out that the government was missing an opportunity to finance its deficits and stimulus measures at once in a lifetime 30 year long term rates in favor of cheaper short term levels. We suggested that that rate rises were inevitable, could come quickly and that waiting would have significant incremental costs to the US taxpayers as well as US corporate debt issuers whose bonds are priced at a spread to US Treasuries. The analogy of Americans who are using ARMs rather than financing long today is an apt comparison that most Americans can readily comprehend. They would not do what the Treasury is doing!!

At the time of our April post, 30 year Treasuries were trading at approximately 3.6%. Today 10 year treasuries are at 3.93% and 30 year Treasuries are now at 4.69%! A 100 basis point or 30% rise in six weeks is bad news. Worse yet, the 10 years are only at that level due to intervention by the Fed and treasury to keep yields below 4%.
That 100 basis point swing alone would result in an annual financing cost of an incremental annual cost of $10billion on $1trillion of debt. Even if we were to just finance for 10 years rather than the previously suggested 30 years, the cost would be $3billion more annually than had we financed for 30 years 7 weeks ago. To make matters worse, Brazil and Russia are making serious noises about dumping upwards of $10billion in treasuries in favor of new IMF bonds. This could be a leading example for other foreign governments to diversify their foreign reserves away from US Govt. obligations. India and China frequently follow in tandem with the actions of Brazil and its Central Bank wizard, Henrique Meirelles. The cost to taxpayers and US corporates would be huge and could significantly impair prospects for economic recovery.

I find it tragic that a socialist nation like Brazil is exhibiting far more economic discipline in financing its deficits and managing its reserves that the United States.
They are not confused between acting in their economic best interests vs. using the Treasury or Central Bank as an instrument of social policy. Likewise, they are very careful to evidence a strong respect for lender rights and the rule of law as it impacts their access to the capital markets.(

Add to these problems is the fact that investors at home and abroad are increasingly worried about the US Government’s lack of respect for the rule of law regarding lender rights in bankruptcy (e.g. GM and Chrysler). America won’t go the way of Weimar Germany but stagflation (inflation without growth) is a real possibility. Savings will be diminished and businesses will become less and less competitive globally. As an investor, government policy leads me to buy mostly foreign securities and inflation hedged companies with assets like oil and iron ore. As a card carrying Democrat, I am troubled for my country’s economic future. We can and must do better.

Follow the links below for copies of prior posts on financing the Treasury and Brazil’ Central Bank President

Mary Anastasia O’Grady has an excellent and insightful piece on Brazil’s ongoing success in the current market turmoil. She also points to the irony of a Socialist President calling for more free trade and the possible “United States risk” in Brazil’s economic future. In particular, she notes issues with Citibank financing trade and a declining dollar as impediments to Brazil’s continued success. The one major item that she missed was that the secret key to Brazil’s success has been the vigilence and fortitude of their Central Bank President, Henrique Meirelles. In the face of cries to lower interest rates and a more “American” like monetary policy, he has persevered in the best interests of his country. He deserves much of the credit for Brazil’s success. Lula also deserves great credit for not succumbing to calls from the left and the right to ease up on Meirelles economic vigilence. They both deserve kudos for a continuing job well done!

Mr Thaler is currently the Managing Partner of Lieutenant Island Partners, an organization providing corporate finance advice and general consulting to corporations and not-for-profit organizations. Mr Thaler retired as Vice Chairman of Deutsche Bank Securities in early 2008. His background includes experience as an investment banker, senior manager, business builder, college professor, not for profit board chair and trustee. In his thirty plus years as an investment banker for Deutsche Bank and Lehman Brothers, he has been involved in numerous significant debt and equity financings, mergers & acquisitions, leverage buyouts, restructurings and cross border transactions.
Of particular note, Mr Thaler has been one of the most active participants and strategic advisors to the homebuilding industry. In a period of significant turmoil and losses, he was one of the few active bankers to the industry who did not have either a loss or credit write down. He is currently advising several public builders on strategic matters and is an adjunct professor of finance at Morehouse College in Atlanta, Georgia. Though he lives in New York, he is a life long Red Sox fan!
www.LieutenantIslandPartners.com